In In re Mutual Funds Investment Litigation, the U.S. Court of Appeals for the Fourth Circuit reversed and remanded a district court’s dismissal of a putative class action complaint brought by shareholders of a publicly traded asset management firm against the firm and one of its subsidiaries, a mutual fund adviser, for damages allegedly caused by misleading disclosures in the defendants’ mutual fund prospectuses. The plaintiffs alleged that the defendants’ prospectuses contained misleading statements relating to their policies for prohibiting and preventing market timing trading in their mutual funds and fraudulently induced investors to invest in the funds. Contrary to the statements contained in the prospectuses, the funds’ managers allegedly permitted significant market timing transactions to occur.
The issues on appeal involved whether the complaint sufficiently alleged reliance and causation to maintain a cause of action for securities fraud under Section 10(b) of the Securities Exchange Act and Rule 10b-5. The court held that the complaint sufficiently alleged fraud-on-the-market reliance against the fund adviser because interested investors relied on misleading statements in the prospectuses, which were made available to the public. In addition, because the prospectuses listed the adviser’s duties to the fund and stated that it provided advice and recommendations relating to the fund’s investments, they were deemed attributable to the adviser. The court also held that the plaintiffs sufficiently pled causation against the adviser, reasoning that the decrease in the value of the parent firm’s stock that occurred when the fraud was publicly revealed indicated a link between the misleading prospectuses and stock value.
The court declined to allow the fraud-on-the-market claim against the parent firm to go forward on the grounds that the firm’s role in disseminating the prospectuses on its website was not a sufficient basis for investors to infer that the firm had prepared and approved them. The plaintiffs, however, adequately alleged a claim of control person liability against the parent firm due to the fact that it wholly owned and shared management with its subsidiary fund adviser and had the authority to regulate the adviser’s market timing activities.